The opportunities and challenges of greener growth: Getting the whole policy package right

Climate change and, more generally, environmental damage have quantifiable economic and health costs, which weigh on long-term growth and well-being. If left unchecked, climate change is projected to decrease global GDP by 0.7 to 2.5 % by 2060. At the same time, the costs to society of air pollution already appear substantial–equivalent to some 4% of GDP across OECD countries and even higher in some rapidly developing economies. Yet global action in the environmental domain proceeds only slowly–too slowly to be up to the challenges we face. Why is it so?

One primary goal of environmental policies is to encourage firms and households to reduce the damage they do to the natural environment, for instance, by adopting new technologies, ideas and products that improve environmental performance. Policymakers have long feared that such policies would be a constraint on their country’s competitiveness–a number of empirical studies attempted to attribute a significant part of the 1970s productivity slowdown in the United States to the increasing role of environmental policies. But a shift is starting to take place which should make environmental policies politically easier to advance.

One reason for the shift is that the claims of overall negative effects of environmental policies have found little backup in research. In fact, anecdotal evidence has been rather comforting: growth did not collapse after the implementation of numerous environmental policies over the years, be it unilateral introduction of environmental taxes or broader global actions, such as the Montreal Protocol to reduce ozone layer depletion.

Moreover, new compelling evidence from the OECD indicates that the economy and the environment can be improved together. Based on the experience of a large set of countries, it shows that productivity has generally not been negatively affected by policies that promote care for the environment. Yes, policies require some temporary adjustments, but these tend to wash away within a couple of years.

As importantly, the most productive and technologically advanced firms (and industries) tend to actually gain from tighter environmental policies, an outcome likely reflecting their superior ability to grasp the new opportunities by innovating and improving their products, but also by relocating their production abroad. In contrast, the least productive firms–which generally use their resources less efficiently–may see a temporary fall in their productivity growth, possibly as they require more investments to cope with the more stringent environmental requirements. Some of the least productive firms may cease to operate. Still, if resources are swiftly reallocated to young and expanding firms, the overall impacts will not necessarily be negative and can be positive, both for the economy and the environment, particularly if policies are in place to enable entry and exit of firms and to support employment.

Our evidence on international trade and the environment adds another positive perspective to this picture of the effects of environmental policies. A recent analysis shows that more stringent environmental policies spur the development of a market for a whole range of equipment specifically intended for preventing and abating pollution. Indeed, it concludes that stringent regulation positively affects countries’ specialisation in environmental products, which is a rapidly expanding global market. Increased trade in such products can spur global improvements in environmental quality. In fact, when combined with stringent, well-designed environmental policies, open trade can form a vital channel for reducing pollution and spurring growth both globally and domestically.

Economic dynamism is crucial to ensure such positive outcomes, and policy design can do a lot to contribute. The overall policy framework should be oriented to encourage growth of young and dynamic firms, and the development of new products and ideas that fulfil tighter environmental standards. Such policies include minimising barriers to market entry and competition, improving access to financing, and promoting trade and innovation to ensure those new products and ideas flow in. But, equally importantly, the actual design of environmental policies matters. The keywords are flexibility and competition: market-based instruments, such as green taxes, that leave the choice to the firm as to which clean technology to use, tend to have more robust positive effects on productivity. On the contrary, while rules to spur markets are important, policies that lead to excessive and unnecessary green (red) tape or provide advantages to incumbents, such as laxer norms or subsidies that prop up dirty and inefficient firms, can prevent both environmental and economic progress.

Many OECD countries appear to be waking up to these new policy options for doing better in designing both general framework policies and environmental policies. Similarly, countries can also do much more to align policies across many different areas, such as taxation, investment, land-use or sectoral policies, to be more consistent with environmental goals. They can learn from countries where even stringent environmental policies are also competition-friendly and can support the entry and scaling up of new cleaner technologies, products and business ideas.

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A complementary approach to enabling the labour market to adjust is also important, particularly as higher productivity firms will need to be able to attract the correctly skilled workers in order to maximise their advantages. In sum, reforming environmental policies in this way can facilitate the achievement of both environmental and economic objectives and help forge a healthier, more prosperous planet.

The author would particularly like to thank Tomasz Kozluk of the OECD Economics Department for his input.

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